AeroVironment’s Mixed Bag

While Wall Street was disappointed with the recent financial results of AeroVironment Inc., the long-term outlook for the company remains positive. Monrovia, Calif.-based AeroVironment (NASDAQ:AVAV), best known as the producer of a line of small unmanned aircraft systems (UAS) for the military market and fast-charge systems for electric vehicles (efficient energy systems, or EES), in March reported financial results for its third quarter of fiscal year 2010, which ended January 30, 2010.

The company announced $60.9 million of revenue for the quarter, an 18 percent growth over its second quarter and up 17 percent from FY 2009 third-quarter revenue of $52.2 million. AeroVironment (www.avinc.com) attributed the revenue increase to higher sales of unmanned aircraft systems ($11.7 million), offset somewhat by lower than expected sales in the EES segment ($3.1 million). But the company missed its Q3 estimate of $73 million. Also, revenue for the first nine months of FY2010 was $150.2 million, down 12 percent from the same period in 2009 ($171.6 million) and lower than projected.

In the Q3 earnings conference call, company officials noted that 2010 revenue was heavily back-loaded, with 70 percent of total 2010 revenue expected to be generated in the second half of the year, with 65 percent in the fourth quarter alone. AeroVironment representatives revealed that most of the missed Q3 revenue was for the Raven B system, for which production was delayed due to start-up issues until this January, the last month of the quarter. (Raven A systems were analog based, while the Raven B, or digital Ravens, are enhanced with digital data link technologies that allow an increased number of aircraft to operate in the same area.) In addition, delayed receipt of Raven orders funded through programs in the U.S. government’s fiscal 2010 budget, signed late December 2009 (two months into the fiscal year), would push a number of orders originally expected in Q3 into Q4 and FY2011, according to company officials.

While Q4 sales are off to a good start (Q3 shortfalls have been made up), AeroVironment admitted that even with heroic efforts, 2010 revenues will fall below planned FY2010 revenue goals. In June 2009, the company announced that it expected 2010 revenue to be 18 to 22 percent greater than FY2009, for a total of $292 million to $302 million. It now anticipates revenue of approximately $245 million, plus or minus $5 million for FY2010, and operating margins (operating income/revenue) in the low double digits, which to date have averaged approximately 14 percent.

Analyst reaction to the quarterly report was mixed. For example, Dougherty & Company and Pacific Crest Securities downgraded AeroVironment to neutral and sector perform, respectively, while C.K. Cooper and Benchmark initiated AeroVironment coverage and recommended a buy. The investment blogosphere, which is largely focused on short-term returns, was not as kind. Robotics Business Review, however, believes the long-term prospects for AeroVironment remain strong. The primary reasons, while not captured fully in earnings reports, include the following:

More Military Unmanned Systems. The 2010 U.S. Department of Defense budget calls for $3.5 billion for unmanned systems of all types (a 23 percent increase). AeroVironment’s Raven has become the small unmanned aerial system (SUAS) of choice for U.S. military services. Joining the company’s Raven, Dragon Eye, Puma, and Wasp systems is another small UAS called Switchblade. Switchblade can carry out intelligence, surveillance, and reconnaissance (ISR) missions like the Raven, but it also carries a small on-board explosive. AeroVironment also has under development its Global Observer system. The liquid-hydrogen-powered unmanned High-Altitude Long-Endurance (HALE) aircraft supports stratospheric global persistence for up to one week. The Switchblade and Global Observer platforms provide the company with entry into entirely new UAS markets.

More Civilian Unmanned Systems. The civilian unmanned aerial systems market is in its infancy. Efforts are under way, however, to open up commercial airspace to unmanned systems for civilian security and surveillance applications such as boarder control, environmental monitoring, scientific studies, and so on. Like other UAS providers, AeroVironment’s field-proven SUAS and high-altitude, long-endurance (HALE) platforms are well suited for these types of commercial applications.

Reputation. As a small defense contractor, AeroVironment is less well known than large primary contactors such as Raytheon and Lockheed Martin. However, in military and UAS circles, the company is well regarded and respected, a little-discussed factor that plays a major role in contract awards. As the government is the customer for homeland defense and security purchases, the company’s reputation should extend into these markets as well.

Electric Vehicles. AeroVironment’s EES segment is weak, but as the recession abates, capital expenditures will increase and the industrial sector will continue to automate (as it must to remain competitive). In February 2010, AeroVironment announced a contract to provide the charging system for the Nissan LEAF electric vehicle. The consumer market for electric vehicles is unproven and somewhat suspect (Nissan is projecting sales of only 5,000 LEAF cars), but the U.S. government is committed to converting its fleet to other electric systems where appropriate.

Acquisition Target. The U.S. FY2011 defense budget removed any uncertainties regarding the role of unmanned systems in the future. For defense contractors, this positive news was offset with reductions in, and elimination of, other major defense programs. To compensate for their losses, large defense contractors will seek out smaller firms that offer proven technology in niche markets. Militaries across the world are hot on unmanned systems, and as the market leader for small unmanned aircraft systems, and provider of a HALE platform with the Global Observer, AeroVironment will become an acquisition target. The company’s clean balance sheet, protected intellectual property, and large cash and investment holdings ($127 million vs. only $37 million in liabilities), make acquisition even more compelling.

The Bottom Line AeroVironment’s anemic third quarter results belie market drivers that indicate the potential for strong long-term growth. These include the popularity of the Raven UAS, the entry into new markets with the weaponized Switchblade and HALE Global Observer platforms, and the continued growth of both the military and civilian unmanned aerial systems market. AeroVironment’s EES segment will continue to struggle, but should rebound as the economies recover or as fleet sales increase electric vehicle production. AeroVironment is also an acquisition target for primary defense contractors seeking to expand their UAS portfolios.